Principles of Accounting Flashcards
Define accounting
The process of identifying, measuring and communicating info to permit informed judgements and decisions by users of the info
Purpose of accounting
to discharge the accountability function of management & to influence the decisions of those who . use the info provided
2 fundamental qualitative characteristics of accounting
- relevance (must be able to influence decisions/be predictive/confirmatory value)
- Faithful representation (complete, neutral and free from error)
4 Enhancing qualitative characteristics
VUCT
- Verifiability (independent observers would come to the same conclusion)
- Understandability (clear, concise to users of the info)
- Comparability (across time periods to id simlarities/differences within and across an entity)
- Timeliness (must be produced in time to aid decision making)
Financial v Management accounting
Financial: Income statement, balance sheet, cash flow statmeent (external user focus)
Management: Planning & budget, costs, pricing (internal user focus)
Outline the accounting process
- Business transactions occur
- Entered into accounting info system which are then turned into special purpose management reports or special purpose reports for tax returns + other reports for gov agencies.
- Or they become general purpose reports (income, balance, cash flow)
Conceptual frameworks of financial reporting - the principles of accounting
- entity concept
- Accounting time period concept
- Cost principle (historic)
- Matching principle (expenses recorded in same accounting period as the respective revenues, regardless of when the transfer of cash occurs- for accrual acc only)
- Profit recognition principle
- The conservatism (prudence principle)
- The going concern principle
3 main types of financial report
- Statement of cash flows
- Income statmenet (Statement of financial position)
- Balance Sheet (Statement of financial performance)
- Statement of cash flows
shows inflows & outflows of cash for the period + opening & closing balance
- Income statmenet (Statement of financial position)
measures profit made in a period (profit= revenues- expenses)
Stock of wealth at a point in time
- Balance Sheet (Statement of financial performance)
show’s a business’s assets & claims on those assets. (claims always relate to external liabilities)
Flows of wealth over time
Accounting Equation
Assets= liabilities + OE
OE accounts
Capital, drawings, revenues, expenses, dividends
The entity concept
states the business activities & personal affairs of the owner are separate
Accounting time period concept
Defines the unit of time that accounting data is collected & financial statements prepared usually end year on 30 June
Cost principle
states that assets and services acquired must be required at their actual cost when purchased. (achieves reliability and objectivity)
Matching principle (for accrual accounting only)
Expenses must be recorded in the same accounting period as the respective revenues, regardless of when the transfer of cash occurs (vs opposite–> cash basis of accounting)
Financial objectives of a business?
to enhance the wealth of owners - risks levels associated with the business must be balanced with the required return
return vs risk
return= gain resulting from particular event risk= likelihood that what's projected won't actually occur
Short term gains can lead to
long term problems –> GFC (securitisation of loans were separated from original human origin and sight of the big picture was lost from greed & poor stewardship)
Revenue/profit recognition principle
states that one should only record revenue when it has been earned, not when the related cash is collected
conservatism/prudence principle
is the general concept of recognising expenses and liabilities as soon as possible when there is uncertainty about the outcome, but to only recognise revenues and assets when they are assured of being received.
Going concern principle
where accountants assume that the business will continue operating for the foreseeable future.
Why do we have the going concern principle?
If going concern principle wasn’t the case:
—> the business would have to convert all assets to cash based on current market value, instead of just reporting assets & liabilities on the basis of cost adjusted where appropriate for specific values
Sole proprietorship- definition + features
single owner in business on their own account.
- separate accounting entity
- one legal entity (no distinction–> the legal owner enters into contracts, sole proprietor is personally liable )
- life span: limited by owner’s choice or death
- minimum reporting regulations
- easy to set up
- limited no. owners
definition + features partnership
Partners : 2+ owners carrying on a business for profit
- separate accounting entity (partnership is separate from the individual partners)
- one legal entity (partners are personally liable)
- Life span: limited by owners’ choice/death
- greater reporting regulations –> Partnerships Act gives direction for responsibilities
- simple to form
- limited membership (of 20 usually)
definition + features shareholders
Shareholders, usually many
- separate accounting entity ( of company from the shareholders)
- separate LE, CEOs are liable, but shareholders not personally liable
- Life span: indefinite (easy transfer of ownership)
- Extensive government regulations
- Very tricky to set up (apply to ASIC, need ABN, board of directors)
- Unlimited no. members
Advantages of sole proprietorship
1) easy to set up/operate
2) minimum financial reporting regulations
3) ownership & management normally combined (total undivided authority)
4) All financial rewards —> 1 owner
5) timely decision making
Advantages of Partnership
1) greater access to capital
2) partners bring different skills
3) greater management flexibility
4) Tax advantage since income spread btw partners
Advantages of Limited Company
1) separate legal entity
2) limited liability of shareholders
3) easy transfer of ownership
Disadvantages of sole proprietorship
1) unlimited legal liability
2) restricted access to capital
3) limited experience/knowledge
4) limited access to non-ownership funding
Disdvantages of Partnership
1) unlimited personal liability for partners
2) need partnership agreement to prevent future problems
3) mutual agency, exposed to greater responsibility (you’re responsible for other partner’s actions)
4) reduced decision making authority
Disadvantages of Limited Company
1) separate ownership and control
2) extensive gov regulations
Difference between cash and accrual accounting
In cash accounting, the transaction is only recognised if it involves an immediate cash inflow/outflow.
For accrual based accounting, the cash system is extended to include a variety of non-cash transactions ie credit extended to or by the entity.
-> employs a wider criteria to decide whether revenue has been realised or expense has incurred.
Analysis of accrual based accounting
employs a wider criteria to decide whether revenue has been realised or expense has occurred.
BUT as test other than cash flows are less easy to define, some certainty + objectivity is lost
Analysis of cash based accounting
Cash flows are useful to recognise, however don’t give a satisfactory measure of the performance of the enterprise.
Differnece btw ledger and journal
The Journal is a book where all the financial transactions are recorded for the first time. When the transactions are entered in the journal, then they are posted into individual accounts known as Ledger. The Journal is a subsidiary book, whereas Ledger is a principal book
